High-Rise v. Garden-Style: Examining the Path to Prosperity

Modern times offer exciting opportunities for direct real estate investors. With properties across the spectrum realizing a significant growth trajectory, real estate investments can offer both attractive returns and diversification benefits. Specifically, apartments offer a long track record of favorable risk-adjusted returns, a higher dividend payout ratio and healthy growth of net operating income (NOI) relative to other property types. However, to determine the right strategy for apartment investing, investors have myriad factors to consider before deploying capital. All of the calculations, analysis and forecasting culminate into one overarching goal: to maximize returns and minimize risk.

Following the Great Financial Crisis, apartments have been a clear investment winner among real estate sectors due to declining homeownership rates, tighter mortgage standards, demographic trends and desire for flexible living. The apartment sector is comprised of several different property types, leaving investors to wonder which product type is the better bet. To determine the answer, this piece will analyze growth across rental rates and NOI, as well as dive into the components of total return to determine whether high-rise or garden-style apartments provide the most effective path to prosperity.

Key performance differences by property type

Higher effective rents – which drives NOI growth – is the foundation for real estate investment performance. Figure 1 illustrates that the clear winner for rent growth is high-rise apartments. Given the outperformance, it is not surprising that high-rise apartments also tend to produce superior NOI growth (see Figure 2). In fact, during the previous 15 years, NOI growth in high-rise apartments has exceeded garden-style apartments on average by 270 basis points (bps) per annum. However, superior NOI growth does not come without risk. High-rise apartments also experience more volatility. This might seem counterintuitive since high-rise apartments tend to be viewed as “recession proof” because they attract more renters by choice. But it is this very fact that belies the volatility: renters can come and go, especially if another more spectacular product comes to market. High-rise renters command the income to allow for such agility.

Where do garden-style apartments excel?

Since total returns incorporate both an income and appreciation component, it is important to note that garden-style apartments enjoy an income advantage. Figure 3 shows on average, garden-style apartments have maintained an income yield advantage of 73 bps on an annualized basis during the previous 15 years. More recently, that premium has expanded to roughly 124 bps as asset prices of high-rise apartments have been bid up.